Friday, January 11, 2013

Blog On Economics With A Strong Japan Component

Okumura Jun has linked to Dr. Noah Smith's blog Noahpinion and it is a worthwhile read (Link). Dr. Smith is a rare Japan hand in the high stakes economics blogosphere, having lived in this blessed land for a number of years. Dr. Smith has some admirers in Japan, notably noted economics blogger Ikeda Nobuo, who has allowed Dr. Smith to post on his Agora site. (Link)

In his latest post on Japan's economy, "Should Japan Reflate?" Dr. Smith wonders whether it matters much if the monetary and fiscal policies of the Abe Cabinet trigger high levels of inflation or even hyperinflation. In his judgment, it would not. (Link)

I hesitate to agree with his conclusion.

While I have to agree with the self-evident statement that inflation destroys debt, which would be good for the economy, it would also destroy the value of bonds, which would be bad. Dr. Smith refers to such value destruction as a "tax" on elderly bondholders -- which it is in terms of outcomes. However, high or hyper-inflation would be dishonest taxation, one not vetted by an electoral test.

Inadvertently Dr. Smith's post highlights, rather than dismisses, the danger posed by the Abe government's enthusiasm for inflation. Dr. Smith claims that previous global incidences of hyperinflation have not been terribly damaging, at least from an economics standpoint (his use of Weimar Germany's hyperinflation as an example of a benign result tests my patience. As I remember, the collapse of faith in the Weimar government had a decidedly negative political outcome). As is often noted, almost all of Japan's debt is held by Japanese investors and institutions. What this means is that if inflation takes off, Japanese creditors get torched. This is completely different from the Latin American hyperinflations, where economic irresponsibility burned overseas bondholders as much as domestic ones (Argentina defaults and Italian pensioners are ruined, in the most recent example). High or hyper-inflation in this latter case is like lighting a stick of dynamite, throwing it, getting knocked down by the shockwave, then picking oneself up grinning, saying, "Whew, that was fun!" In the Japanese case, with Japanese on both sides of the creditor-debtor divide, inflation is like lighting a stick of dynamite, then holding on to it.

8 comments:

ross
said...

No need to become impatient, the Weimar experience with hyperinflation did not lead to the breakdown of that republic as it mostly ended by late 1923 early 1924. Rather, it was nearly a decade after the inflation had been overcome that the Nazi's rose to power in the wake of the Weimar govt's maintenance of a gold standard amid depression era deflation. So it was the opposite economic problem that brought Weimar down, contrary to popular misconceptions.

The hyperinflation of the Weimar republic may have ended (brought under control mostly) by early 1924, however the price of bringing it under control had a heavy toll on middle & lower classes in particular – austerity policies etc. Add to that the (political) resentment for the Versailles Treaty and lingering inequalities in the German society (predating WW1). I don’t think the German economy ever fully recovered from that hyperinflation period, when the 1928-1930 crisis hit.

Abenomics might conceptually be a good idea actually - contrast with the austerity policies in Europe; the devil is in the execution of course. As you (MTC) have noted before, it is much corporate welfare for the friends of the LDP. Lots of money will disappear into re-floating the dinosaurs among the JPN corporations, but little will go to support ‘new’ businesses and economic development.

Sure, the experience with hyperinflation probably didn't make the regime many friends. But it was a very decentralized regime with fragmented parties and a weak chancellor position. All that diluted accountability. Political structures needed to be more decisive/accountable and when push came to shove, the pendulum swung way hard in the other direction.

But my key point is that it was the budget austerity of the early 1930s, not budget profligacy of the early 1920s that gave rise to an authoritarian impulse. (I am not saying hyperinflation couldn't bring about the same result, merely that it didn't in this case.)

On Abe's call for expansionary fiscal and monetary policy:

Sure, Noah Smith is correct that Abe is not going to test the implications of NGDP targeting in a controlled manner, but that is expecting far too much. I really don't like Abe on many levels, and I am pretty certain his (the LDP's) rise undermines hopes for structural reforms being taken directly by the govt.

That said, reflation is also necessary and higher real interest rates will have some of the effects of structural reforms. For example, the financial sector was in part deregulated under PM Hashimoto but the creative destruction that could have released was never felt because ZIRP keeps zombies alive, making it harder (impossible?) for stronger firms to displace them. Japan offers a much more open economic environment than it did in 1990, I am hoping some inflation will help shake that all up, resulting in some structural change that would be politically impossible to legislate.

Similarly, if Abe can get DPJ support to go over the TPP cliff together, that would also, eventually, produce structural change without having to push it through the Diet, by promoting competition in some sectors where it is presently limited.

Since structural reform has been mostly dead in Japan legislatively, even under Koizumi popular impressions notwithstanding, getting reflation may be half a glass of water. The DPJ was offering neither reflation nor much in the way of structural reform so the glass had been empty. So in terms of economic outlook, Abe's an improvement. Sad to say.

I agree that the primary downside of hyperinflation is the political risk.

But notice that I also think the chance of hyperinflation is very low in the first place, no matter what sort of monetary policy Abe enacts.

So I think that while a policy of "reflation" is not without risk, the risk is reasonably small.

I still think the safest way for Japan to avoid a default is to raise taxes to European levels (studies have shown that Denmark-level taxation would balance the budget). However, though this is the safest, it is not necessarily the optimal policy, since it will entail many more years of grinding economic stagnation.

Of course, Japan's leaders may be - indeed, most likely are - more risk-averse than an econ blogger with no skin in the game.

As an aside, I think that structural reforms are very important for Japanese growth, especially in the areas of labor markets and corporate governance. The whole discussion of "reflation" is largely a sideshow compared to that more important struggle, in my opinion.

From my reading of various wikipedia articles, it was the timorous center-right governments of the late 1920s and early 1930s that did the Weimar system in.

Each chancellor got progressively worse!

Brüning, Papen, and then General Schleicher as German socio-political order began disintegrating under the stress of the depression.

The 1920s good times was purchased on American credit, more or less, and when credit collapsed in 1930 the centrists went for austerity, until Schleicher started mooting stimulus projects in 1932-33 (just like Hoover at the time).

Hitler as Chancellor and then Führer of course took the ball and ran with this, with creatively-financed construction and armaments funding to put German men back to work.

And as for inflation vs. bondholders, this is a difficult question. I oscillate on this like an old National fan from the 70s, but on my bad days I believe Japan's quadrillion yen of bond debt is simply evidence of taxes that should have been paid but weren't.

Thinking like this, the bond burden on the young is forcing them to pay on the elders' savings.

Less debt is equivalent to savings, so it's not all bad, but it's ridiculous IMO that Japanese pay about half the tax-to-GDP of the nordic states and Germany.